Uncertainty and the Global Recovery

by Don Alexander
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

Bouts of elevated uncertainty are defining features of the sluggish global recovery from the financial crisis.    A number of analysts suggest a link between the high level of uncertainty and the weak recovery.  Uncertainty is associated with escalating financial stress in the Eurozone, stalling US labor markets, and slowing growth elsewhere.  The authors ask two questions: how has uncertainty evolved and how does it affect growth and business cycles?  This is asked by Kose and Terrones is a recent VOXEU communique Uncertainty Weighing on the Global Recovery. 

Economic uncertainty refers to an environment in which little or nothing is known about the future.  There is a great variety of sources of economic uncertainty, including changes in economic and financial policies, dispersion in future growth prospects, productivity movements, political events, and natural disasters 

The authors consider four measures of uncertainty: (1) the standard deviation of daily stock returns, (2) an indicator of the implied equity volatility, (3) an uncertainty index of economic policies; and (4) a global uncertainty index.  Both macroeconomic and policy measures of uncertainty rise during global recessions.

Policy uncertainty in the US and the Eurozone has remained high since the global financial crisis and the recent sovereign-debt problems. Moreover, during the lethargic global recovery, uncertainty has been unusually high and volatile in contrast to other global recessions, which were accompanied by steady declines in uncertainty.  Uncertainty is highly countercyclical at a national level while macroeconomic uncertainty varies over the business cycle.

Economic theory suggests that macroeconomic uncertainty can have an adverse impact on output through a variety of channels.  The authors find the growth rate of output is negatively correlated with macroeconomic uncertainty.  Policy-induced uncertainty is also negatively associated with growth.  The recent increase in policy uncertainty may have stunted growth in advanced economies by 2.5%. The degree of economic uncertainty appears related to the depth of recessions and strength of recoveries.  In particular, recessions accompanied by high uncertainty are often deeper than other recessions. Similarly, recoveries coinciding with periods of elevated uncertainty are weaker than other recoveries.   

Elevated uncertainty historically coincides with periods of lower growth, and the recent pickup in uncertainty raises the specter of another global recession. Policymakers can do little to alleviate the intrinsic uncertainty economies typically face over the business cycle.  However, policy uncertainty is unusually high, and it contributes significantly to macroeconomic uncertainty.  By implementing bold and timely measures, policymakers can reduce policy-induced uncertainty and help kick-start economic growth.

www.voxeu.org/article/uncertainty-weighing-global-recovery